How to invest like a venture capitalist


Venture capitalists, those who risk funding relatively young companies, can easily lose money in most of their investments.

As venture capitalist Paul Graham writes, “effectively all the returns are concentrated in a few big winners.” But those winners can be huge. Take Accel Partners, which invested US$12.7 million in Facebook (Nasdaq: FB) in 2005. The IPO netted the venture firm US$2.2 billion, well over a 10,000% return, and afterward it still owned a hefty amount of the company.

How can you emulate these risky, but sometimes extremely rewarding investors?

Different tenets of different investing
Paul Graham also says that he backs founders over ideas, meaning the people behind the idea matter more than the idea itself:

Ideas are just indicative of how the founders can think. We look for relentlessly resourceful people. That combination is key. Relentlessness alone is useful. You can relentlessly just bang your head against the wall. It’s better to be relentless in your search for a door, and then resourcefully walk through it.

Obviously, this approach to looking for investments is the opposite of what someone like Peter Lynch advocates when he says, “I like buying companies that can be run by monkeys — because one day they will be.”

This highlights a few key differences if you want to invest like a venture capitalist. Whereas long-term investors like Warren Buffett preach that their favourite holding period is forever, venture capitalists cash out once a company gears down its growth. And whereas you could invest in a stable, dividend-paying business that a monkey can run, you can also take more risk by betting on the right leadership while the underlying business may need work.

What kind of leadership?
The qualities you should look for include integrity, honesty, and an ability to solve customers’ problems. And while it’s easy to rattle off a list, let’s look at some real leaders to get a better idea of what to look for.

Pivoting on a disc
You may have heard that Reed Hastings, CEO of Netflix (Nasdaq: NFLX), came up with the idea of a DVD-by-mail service after getting dinged by a US$40 late fee from the traditional movie rental option. You may not have known that before Netflix, Hastings made US$75 million after selling a software troubleshooting company. Hastings has a history of creating solutions for customers, albeit with some setbacks along the way. The important thing is that he’s honest about the difficulties.

He began Netflix by charging per disc rented, then pivoted to a subscription service. Then he pivoted the company to streaming movies, and tried to pivot too far by splitting the mail and streaming businesses. Netflix once was worth over US$15 billion, and now sits with a market cap of a little above US$3 billion. If Hastings lives up to his history and pivots correctly again, the risk of Netflix could be well worth the future reward.

A new job market
Another PayPal alum, who left after it was acquired by eBay (Nasdaq: EBAY) in 2002, is LinkedIn (NYSE: LNKD) founder Reid Hoffman. Hoffman, who made US$111 million on a US$37,500 investment in Facebook, took the idea of a social network to the workplace. Hoffman adds another possible asset of a good leader: their professional network. As Hoffman told NPR, “Part of the reason I think there’s been such success from the PayPal crew has been that we were all really intensely helping each other with all of these classic entrepreneurial problems.”

Investing in leaders
You can start to find out more about the leaders of public companies through a company’s proxy filings, and I highly recommend you do that for every stock you own or consider. Even if monkeys can run a company, you shouldn’t trust those monkeys with your money. Take a note from venture capitalists, and look for the type of leadership represented by the above founders.

If you’re in the market for some high yielding ASX shares, look no further than our “Secure Your Future with 3 Rock-Solid Dividend Stocks” report. In this free report, we’ve put together our best ideas for investors who are looking for solid companies with high dividends and good growth potential. Click here now to find out the names of our three favourite income ideas. But hurry – the report is free for only a limited time.

 More reading

The Motley Fools purpose is to help the world invest, better. Take Stock is The Motley Fool’s free investing newsletter. Packed with stock ideas and investing advice, it is essential reading for anyone looking to build and grow their wealth in the years ahead. Click here now to request your free subscription, whilst it’s still available. This article contains general investment advice only (under AFSL 400691). Authorised by Bruce Jackson.

A version of this article, written by Dan Newman, originally appeared on fool.com

OUR #1 DIVIDEND PICK FOR 2016...

Forget BHP and Woolworths. This "dirt cheap" company is growing like gangbusters, and trading on a 5.6% dividend yield, FULLY FRANKED (8% gross). With interest rates set to stay at these low levels for years to come, for hungry investors, including SMSFs, this ASX company could be the "holy grail" of dividend plays for 2016.

Enter your email below to discover the name, code and a full investment analysis in our brand-new FREE report, “The Motley Fool’s Top Dividend Stock for 2016.”

By clicking this button, you agree to our Terms of Service and Privacy Policy. We will use your email address only to keep you informed about updates to our website and about other products and services we think might interest you. You can unsubscribe from Take Stock at anytime. Please refer to our https://www.fool.com.au/financial-services-guide">Financial Services Guide (FSG) for more information.